Back in mid-July, there was much febrile speculation UK interest rates would finally start rising before the end of this year. Amidst signs of stronger US growth, and predictions the Federal Reserve would raise borrowing costs over the next few months, it was widely assumed the Bank of England would follow suit.
Last Thursday, though, as the UK base rate remained at 0.5pc for the seventy-eighth successive month, speculation of a pre-year-end rate rise dissolved, as some of us predicted. Most analysts now forecast, once again, the Bank of England won’t make a move before March 2016.
The Bank has just introduced a new policy, sensibly in my view, of releasing the minutes of Monetary Policy Committee as its decision is announced. So we already that just one of the eight MPC members voted for an increase this month – fewer than the expected two or three. We’re still a long way, then, from the five-strong majority needed to vote through a rise.
The Bank’s latest quarterly Inflation Report, also published on “Super Thursday” as part of the new communications policy, made a similarly dovish case. The centerpiece was the cut in the MPC’s inflation forecast for the first quarter of 2016 to just 1pc, down from 1.4pc three months ago. It was that adjustment, plus news of the single dissenting voter, which drove the expectations switch. The money markets now foresee, once again, that the first UK rate rise since May 2007 won’t happen until next spring.
The Bank’s near-term inflation forecast has been lowered in part due to the oil price, which is down 30pc since May. But sterling also looms large in the MPC’s thinking. The pound is up 6.4pc on a trade-weighted basis over the last three months – which pushes down import prices. Trade-weighted sterling, in fact, hit its highest level since early 2008 last week, with the strong pound helping to explain why headline CPI inflation fell back to 0pc in June. Core inflation, excluding food and energy, stands at 0.8pc. But the rise in sterling means cheaper imports of both kept the CPI itself flat – and way below the 2pc target. The Inflation Report suggests will continue, with the “the drag on CPI inflation from lower import prices expected to persist for much of the forecast period”.
While acknowledging inflation is “muted”, the Bank remains “vigilant” about future price pressures. The MPC lifted its GDP growth forecasts slightly, to a buoyant 2.8pc in 2015 and 2.7pc in 2016, up from 2.6pc for both years in May. The Inflation Report also noted that consumer spending, housing and investment have been stronger than expected, offsetting export weakness, with Governor Mark Carney remarking that “consumer confidence is now at a ten-year high”.
On top of that, real wages rose 3.2pc during the three months to May, the fastest increase in over five years. That provoked a revision in the MPC’s wage growth forecast for 2015 as a whole to 3pc, up from 2.5pc three months ago. While UK wages are rising, it’s not clear if this is due to skills shortages (which would be inflationary) or rising productivity (which would be less so). What’s certain is that MPC members are balancing in their minds emerging data on the pattern and pace of UK wage growth on the one hand against the disinflationary effects of a stronger pound on the other.
It’s also clear that the Bank remains mindful that systemic dangers – not least a collapsing Chinese stock market and the prospect of a Eurozone meltdown – continue to stalk the global growth outlook. While such dangers remain prominent, any rate rise might need quickly to be reversed – which would seriously dent the Bank’s credibility. That, of course, makes increasing rates very risky.
The same macro dangers loom even larger over the Federal Reserve – which makes me doubt on-going speculation that Fed supremo Janet will announce a US rate rise this autumn. For one thing, America’s recovery is actually pretty flakey. The US economy contracted during the first quarter and, for all the hyperbole you hear on the rolling financial news channels, retail sales remained pretty weak last month, having fallen in June.
The other issue about raising rates, though, both here and in the US, relates to quantitative easing. And this is where analyzing the behavior of the world’s leading central banks these days goes beyond the semi-scientific niceties of eye-balling data and judging the language of committee meeting minutes. For the reality is that both Carney and Yellen, through no fault of their own, are caught between a rock and a hard place.
Since the financial crisis, QE has morphed from a just-about-justifiable emergency medicine, into a grotesque, self-serving lifestyle choice of our financial and political classes. The Fed’s balance sheet has ballooned from around 6pc to just under 20pc of GDP, what that of the Bank of England expanding even more, to just under 25pc of our national income.
After the regulatory fiasco that led to “sub-prime”, some “extraordinary measures” were needed to prevent a deeply damaging liquidity crisis across the Western world. But, for many years now, QE has been less about crisis management than about pumping up equity and government bond prices to levels that belie underlying economic and fiscal realties.
QE, and the closely related policy of keeping interest rates nailed to the floor, has sent stocks to repeated all-time highs despite the lack of truly convincing recovery either here or in the US. It has allowed busted “zombie” banks that should have been thoroughly audited, rendered insolvent, then closed down and broken up, to keep trading.
By absorbing vast swathes of sovereign paper, QE has also meant that, while talking tough on “austerity”, Western leaders have continued to spend heavily and add mightily to government debts. This six-year policy, has, quite simply, allowed the authorities to claim that we’re back to “normal” and economy is on the road to recovery – “look, the stock market is booming and bond yields are down”. The reality is that no-one truly knows what will happen when interest rates rise, and the prospect of QE is no more. Messrs Yellen and Carney have inherited a massive asset price bubble that may need an everlasting supply of oxygen in the form of zero interest rates. Once they go up, that bubble could go bang.
And, into that toxic mix, we must now add the dangerous, potentially incendiary nonsense that is “The People’s QE” – a policy of outright debt monetization that is being proposed by would-be Labour leader Jeremy Corbyn.
This is what happens when the financial and political establishment, for its own convenient ends, promotes a policy that printing free virtual money is fine, does no harm and, maybe we don’t even have to unwind the policy as the government bonds can be “retired” or somehow made to disappear. Along comes an economically illiterate, populist politician who then says “we want some of that” and starts to get the public behind outright monetary expansion to fund schools, hospitals, public sector pay rises and the like – the stuff of Weimar economics.
QE is a slippery slope, as some of us have been warning for years. And no-one knows what will happen on financial markets when our zero-interest policy finally ends. That’s why the decision to raise rates, on both sides of the Atlantic, is now less about the educated analysis of wage data and oil prices than about picking a moment and hoping for the best.